Discount Factor

The discount factor depends on the discount rate and the discount period. It is calculated as 1 divided by one plus the discount rate, raised to the power of the number of periods.

For example, at a discount rate of 8%, the discount factor for a cash flow received in three years is 1 divided by 1.08 to the power of 3, which is about 0.794. A cash flow of 10,000 received in three years is therefore worth about 7,938 today.

Discount factors get smaller as the discount rate rises or the cash flow moves further into the future. At 8%, the factor for one year is about 0.926, for ten years about 0.463 and for twenty years about 0.215.

Using discount factors makes valuation calculations easier to follow and check. In a spreadsheet model, each year's cash flow is multiplied by its discount factor, and the results are added up to give the total present value.

Note: A present value factor means the same as a discount factor. Both describe the multiplier that converts a future amount into today's value.